In the country where the independent audit was invented, back in the Victorian era, the Lex column in the Financial Times has finally bought into one of the messages I have been flogging for years – here -- about the fragility of the global franchise of private-provided assurance -- here:
The Big Four are down to critical mass.
It’s a subtle but real shift in language, away from the usual mushy euphemisms of the regulators, that another large firm failure “could disrupt the market” – as put in the vacuous prose of the EC’s recent Green Paper (see here).
As finally put forthrightly by the peach-colored London paper:
“(I)t is vital to work out how to deal with a repeat of the Arthur Andersen/Enron affair, because four is the minimum number of global accounting groups needed for a healthy industry. Many companies employ one firm for internal audits, another for the external audit and a third to offer consulting advice. The fourth player picks up the slack when a change is needed. Neither regulators nor customers would want to see the Big Four turn into the Big Three.” (emphasis added)
The discussion can now move on, if only by further small and agonizing steps. The next one, which the FT is on the very verge of taking, is the explicit realization that an unsustainable three-firm model will go into immediate collapse – not least because the survivors after the next disintegration, which will occur in another Enron-like spasm of recrimination and finger-pointing, will have neither the appetite nor the resources to pick up the wreckage.
The FT is close, but not there yet – because still fixated on either of two non-achievable approaches:
“(I)f that happened, regulators would be left with two unappealing options. First is a forced split-up of the remaining accounting groups – a plan that would meet vehement opposition. Second, an ambitious smaller outfit could take over the ailing giant, roughly as Nomura took on Lehman Brothers’ European operations. But any non-Big Four auditor would face a huge challenge doing this, since these firms rarely work with big or even midsized companies; they audit only 5 per cent of the UK’s FTSE350.”
Been over this ground often before – here. Opposition aside, not only is there no legal authority anywhere for cleaving the Big Four into smaller bits. As a practical matter such a split would have to be done in all the major global financial jurisdictions – none of which has a regulator or legislature capable of conceiving such an idea alone, much less in concert. In any event, the result would only be a group of smaller and weaker firms, with unevenly distributed personnel, industry expertise and capacity for execution.
And if the FT’s writers would please do their sums, they could face the reality that – good as they may be, and that is not assured -- the smaller firms lack the scale, coverage and execution ability ever to play at the level of the world’s global-scale companies.
There are critics of the large accounting firms whose long-winded rants amount to an unqualified charge of auditor venality and corrupt client deference to the exclusion of public interest.
That is not a view I share, and not only because the perfervid rhetoric fails to offer constructive solutions. It’s because the inter-locking antagonisms that capture and paralyze the current audit structure also imprison a profession caught in an obsolete model of excessive and unmatchable expectations.
The Lex conclusion isn’t wrong:
“There may be better ways to keep the auditing business competitive. Regulators and accountants should look for them now, rather than wait for the next scandal to force their hand.”
To be successful, that search will require escape from the “intellectual capture” that now prevents the entire interested community from conceiving solutions outside their limited vision.
And to be timely, it needs to start now.
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